Brexit implications and impact on Pakistan economy

Brexit is indeed once in a life time event. These sorts of situations arise in eons, and their impact is always unsettling. This is exactly the way the world has reacted to Brexit which surely is not a surprise, albeit a bit harsh vis-à-vis UK. In order to assess how this historic move hit close to home, we need to appreciate the whole phenomenon and dynamics of the EU and the possible thinking of the UK voters.

Brexit decision is not all that sentimental alone as is being perceived. There is perhaps an element of logic and thinking behind it, if we look at it dispassionately. The fact is that the older population in UK has seen how the law and order was compromised and the economy suffered due to immigration pressure and financially supporting the inefficient members of EU. It’s very evident that UK had mostly been on the receiving-end than otherwise. Having said that whatever the logic and thinking maybe, this sort of enormous decision must have been taken with 2/3rd majority; not with the simple majority of merely 1.2mn votes in a population of 65 million, less than 2%. This is ludicrous for such a serious decision to impact the lives of over 500 million people directly and pretty much the entire globe indirectly. This debacle indicts the Cameron Government.

The impact could be deep and far-reaching on EU and its existence; hence, also on all the trading partners of EU, including Pakistan. There are various dimensions to it - short term versus long term; and after-effects of this decision within and outside Britain and EU, both in terms of economy and on the society as a whole.

While there is a host of the unknown at this point, but given the fundamentals and the ground realities, UK seems to be better off at the end of the day. Even in the short run, if Scotland (with Ireland) sticks around, which they probably would, given the choices between UK and EU. The way things will pane-out with UK and EU over the next few months would possibly change the “emotions” of Scots and Irish, which are perhaps all charged at this point. Things are likely to simmer down in due course and sanity will prevail. Concluding that Scots wants to go with EU based on the referendum results is unfair. The dynamics of their earlier referendum to stay in UK were very different than the realities on the ground now and going-forward post Brexit.

Brexit is the beginning of the end of protectionism and unnatural alliances. There’s an overall change in the mindset and the way economies work. Public sector spending in infrastructure and aggressive fiscal & structural reforms (monetary policy as a tool has been largely exhausted) will be the name of the game. These can’t be avoided any further for the struggling economies of EU. Reforms in EU and the EU beneficiary countries is inevitable; otherwise, there maybe more exits, or at least pressure from the people in the receiving countries to exit, which could have serious political and economic ramifications. Some fundamental soul-searching and structural adjustments are on the cards across the globe, particularly in the EU. Brexit will force the European Union to embark on the path of reforms on which they have been dragging their feet for a while. These are defining moments for us and the various economies globally.

In the immediate future, there will be extreme situations - currencies tumbling, markets precipitating, world trade and investment getting impacted, as we have witnessed hitherto. In medium to long term, however, things will eventually get settled, if only Britain leaves. Extended impacts are dependent on how the other counties in EU react - will they also decide to leave, particularly the larger economies like Germany, France and possibly Netherlands. If they do decide to leave then we could see things getting worst; in fact, the very existence of EU will be challenged and hence the troubling economies - PIGS (Portugal, Italy, Greece, and Spain), etc. - will suffer more.

The fact is that services sector contributes 78% of the UK GDP. With English speaking population (not the possibility with other EU Countries except for a couple of them), the relocation of this industry elsewhere in toto within EU is almost impossible. Therefore, UK economy will remain by and large insulated from any economic shocks with the Brexit. Banks and other service industries, may shift some part of their businesses which is specific to the rest of the Europe; moving full operations is highly unlikely and impractical. Once the detailed analysis (regulatory framework, HR availability, language, logistics, etc) are done, they probably decide otherwise. Most importantly, who knows if France (or Germany or Netherlands) is/ are the next to exit EU? Too early for the FIs to announce their intentions to relocate. The relocation may happen due to other reasons, like strict compliance of requirements in UK, etc., but not Brexit, as such.

The other angle is socio-economic. There will be divided societies, across Europe including UK, which could possibly lead to social unrest, particular in the troubling economies with mounting pressure from immigrant and lesser funding support due to exit(s).The long and short of it is that there will be a crisis in medium to long run, depending on how the other large economies of Europe react.

In the immediate future, with Britain leaving, the suffering could be painful but those shall settle-in eventually maybe in the next 5-10 years. A lot depends on how and when Britain will actually leave - the transition could be smooth and in the mutual interest of all, if managed properly and consciously, keeping egos aside during the exit negotiations. The exit plan is to be agreed between UK and EU Countries, post triggering of Article 50 of the Lisbon Treaty, is the most critical aspect in the overall scheme of things, post referendum. In the benefit of all parties concerned, the exit shall be a long and slow process, as abrupt cutting of strings would do more harm than help. In fact, if at all, that may not be practically possible. One thing is very important to sink in that the various treaties, particularly related to trade and business; between UK and the rest of the European Countries could continue as is, irrespective of UK’s status as the formal member of the EU. The arrangements on border may, however, tightened to control the free flow of immigrants in UK.

Given the above thesis, let’s see how Pakistan will get impacted with this earth-shattering event. While the good news is that Pakistan may not get substantially impacted. However, there are a few susceptibilities that Pakistan needs to be mindful of and be prepared to ride the storm. As a matter of fact Brexit may offer some opportunities to Pakistan. In this context, following are the important areas:

1) Exports - big exposure in low quality products to Europe (almost a quarter of the total exports, other than UK), primarily textiles. Post GSP+ status, the exports to EU, including UK, increased by around 23%. Remaining EU is the single largest block in terms of exports for Pakistan. As EU goes through the transition phase, post Brexit, exports could get impacted negatively due to the risk of recession and consumerism which are under-strain already in EU. The Brexit specific incremental effect may not happen immediately, as been argued above, but this is something which Pakistan need to be prepared for. This is the single biggest risk that Pakistan’s exposed to vis-à-vis Brexit. The exports of UK (alone around 8%) are relatively high value-added and those will remain immune to any possible shocks. In fact, this maybe a good opportunity for us to increase our market share in UK. The imports from EU and UK, on the other hand, are not significant; therefore, supply risk is non-existent;

2) Worker Remittances: UK contributes almost 20% of the total remittances into Pakistan, while rest of the EU is merely 3% of the total worker remittances. UK is indeed a significant market for Pakistan. There maybe a blip in the short run, as people will be consolidating their positions/ exposures due to uncertainties around; however, in the medium term there shall be an opportunity to get a better market share from UK as the European migrant pressure subsides, particularly in the white-collar, or maybe in the pink-collar, jobs, including Doctors, Lawyers, Pharmacists, and the other service industry related professionals. The white-collar jobs may also be up for grabs in EU, but for that language skills will be the key. We need to treat worker remittances as an industry and start gearing ourselves up to capture the opportunities across the world. We need to work closely with the interior and manpower ministries of the counties, where there’s an aging population concern, like EU Countries, to figure out the way to ensure that the requisite skills are imparted in our exportable workers and above all compliance clearance screening process to be made robust to address the growing concerns for the workers coming out of Pakistan. This can be argued that the compliance concerns maybe mitigated when the white-collar jobs are targeted. Worker remittances are getting more and more important for our economy and coming close to our export numbers already;

3) FDI: There has been an erratic trend on this front. In any case, the trend in the recent past, for the last three years, has been more focused towards getting FDI from China - reached over 75% (increased from 21% in FY’13) of the total FDI. This is not a very healthy trend given the risk of single country exposure. The share of China in FDI will continue to remain strong due to their commitment to CPEC, and as the other destinations like Europe and Middle East will remain in a consolidation mode. Therefore, on this constituency, the Brexit will not impact much;

4) Grants: UK is a significant player in this arena (60%+ contributor); an amount of over $260 million and growing. Most importantly, this aspect has qualitative value; any hit in this respect may not be the best thing for Pakistan’s already grappling profile, perception. This area may also get under pressure for a while due to cautious approach by the granting/ aiding agencies in UK. We need to make sure that at the diplomatic level, we shall engage ourselves with the UK authorities to ensure non-impairment; and, last but not the least,

5) Social Impact and Law & Order: it’s possible that the marginal economies in Europe come hard on the immigrants, mainly Muslims, with UK quota of immigrants shrinking. The pressure to accommodate immigrants on the remaining EU countries will increase and could result in extreme reactions, which could trigger law and order challenges. Consequently, the Muslim world, along with Pakistan, will get further isolated. Hence visa issues, trading constraints, etc., etc. This will also hurt the exports, remittances, and the economy as a whole.

All in all, Pakistan maybe a sufferer in this situation on the exports fronts, in the long run. Our exports need to find more stable and growing markets like USA and parts of Asia which are markets of high value-added products. In the extended time horizon, UK offer more opportunities to us than threat. We need to position ourselves to capitalise on these opportunities. Remaining Europe may not be good news. It’s future is uncertain to say the least and posses risk for the external account, if we continue to depend on our export destinations in Europe. We need to address our structural issues to make our exports competitive, harness remittances and improve perception issues by going after the opportunities proactively to explore, capitalise on new high-premium, quality conscious, stable, international markets. CPEC delivery and success, in this context, will become even important than before. To reiterate and conclude, there may not be an immediate severe fall-out on Pakistan; however, there’re real vulnerabilities out there over a period of time, particularly on the foreign inflows, in the form of exports, grants, worker remittances, FDIs, etc., which need to be plugged-in through proactive policy decision making and diplomatic actions.